ADT Offered Apollo Strong Value, Says Leading Analyst

In a research report, Imperial Capital states there appears to be a large disconnect between the public and private market valuations for home security and home control companies.

Imperial Capital released an investment research report Tuesday updating its position on ADT Corp. (NYSE: ADT) following its leveraged buyout by private equity firm Apollo Global Management (NYSE: APO).

Shares of ADT jumped as much as 53.7% to $41.30 on Tuesday, but remained below the offer price of $42 per share, or 44.1x reported recurring monthly revenue (RMR). Imperial Capital said it is lowering its rating to in-line from outperform on ADT shares and raising its price target to $42 from $40, about 5% above the recent share price.

ADT Corp. generated revenue of $3.6 billion, adjusted EBITDA of $1.8 billion and adjusted earnings per share (EPS) of $1.95 during the previous 12 months ending Dec. 31. For the quarter ended Dec. 31, the company reported $75 million in cash and cash equivalents and total debt of $5.4 billion.

A share price of $42 (a 56% premium to ADT’s closing price on Feb. 12) values ADT at 13.1x steady state free cash flow (SSFCF) of $938 million, 6.8x during the latest 12 months EBITDA, and 44.1x reported RMR of $278 million, which Imperial Capital calculates at $281 million. In addition, the transaction is valued at 6.5x Imperial Capital’s FY16E EBITDA, 44.1x RMR and 12x its FY16E SSFCF.

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“We believe that this transaction underpins the ongoing consolidation in the growing residential and commercial interactive security industry. On a pro forma basis, combining ADT’s last quarter RMR of $278 million, with Protection 1’s roughly $40 million, creates a company generating roughly $318 million of RMR,” Imperial Capital wrote in the report.

Authored by Jeff Kessler and Saliq Khan, the research report reiterates Imperial Capital’s view that there appears to be a large disconnect between the public and private market valuations for home security and home control companies. At the recent closing price of $26.87 on Feb. 12, Imperial Capital said shares of ADT, while not popular in the market, were significantly undervalued.

“The valuation of ADT appeared unhinged from the traditional private equity and senior lender multiples, and from where public companies in this business have traded historically,” the report states. “At that price, the company, whose vast majority of metrics are improving nearly every quarter, was trading at roughly 20% discounts on respective SSNOCF and RMR bases to where lesser public comps traded in the 2000s [Brink’s Home Security, Securitas Direct], in the 1990s [Automated Security Holdings, Brinks Services], and the 1980s [Wells Fargo, National Guardian].”

Over the next six to seven years, Imperial Capital projects the home services market will add nearly 25 million new accounts, roughly doubling the existing base of approximately 25 million accounts. The very top tier of the dedicated life-safety security market will take five to six million of those accounts (6% CAGR), and cableco and telco firms’ “new-age automation” will take the rest, with the bottom tier of security companies lagging, according to Imperial Capital. ADT is especially well positioned, with leading technology partners, in the small-and-medium (SMB) market, according to the report.

Imperial Capital bases its one-year price target of $42 on several criteria, including 12x its estimated SSNOCF approaching $1 billion by year-end FY16, consistent with comparable trading and transaction multiples of 10x-13x for larger alarm monitoring companies over the past five years. This implies 6.5x EV/EBITDA based on Imperial’s FY16 adjusted EBITDA estimate, and 44.2x EV/RMR based on the firm’s calculation of $278 million of current RMR. The firm said it equally considers five critical operating metrics against ADT’s comps: ARPU growth, attrition, customer creation multiple, SSFCF and RMR.

Combing the operations of ADT and Protection 1 could create a very stout competitor in the industry, the research report suggests.

In the last two years, even as the penetration of wireless interactive systems has greatly increased and sales of POTS systems have fallen to what Imperial Capital estimates to be below 30% of new systems, significant challenges to find competent network service systems and personnel, as well as continuing “customer touch” services, have begun to put pressure on monitoring and service margins, in all but those few companies that have the infrastructure, customer training, and internal “IT-IQ” personnel in place.

“An ADT-P1 combination only makes this division between the largest ‘haves,’ the smaller ‘haves,’ and ‘have-nots’ even starker,” the report states.

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